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Chapter 11: Problem 19

Explain how gains or losses on impaired assets should be reported in income.

Short Answer

Expert verified
Impairment losses are reported in the income statement as part of profit or loss, shown as a separate line item to highlight their financial impact.

Step by step solution

01

Understanding Impairment

Impairment occurs when the carrying amount of an asset exceeds its recoverable amount. To measure impairment, it's necessary to calculate the asset's recoverable amount, which is the higher of its fair value less costs to sell or its value in use.
02

Recognizing the Loss

If the carrying amount exceeds the recoverable amount, an impairment loss should be recognized. This loss represents the decline in the asset's value and should be accounted for in the financial statements.
03

Reporting Impairment Loss

Impairment losses are reported as part of profit or loss in the income statement. Specifically, these losses are included in the income from continuing operations before income taxes and displayed as a separate line item to highlight their effect.
04

Impact on Financial Statements

In reporting, the asset's carrying amount is adjusted by the amount of the impairment loss. This adjustment impacts both the balance sheet (lower asset value) and the income statement (recorded loss), providing a comprehensive view of the asset's diminished value.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Financial Reporting
Financial reporting is a critical aspect of a company's interactions with stakeholders, providing essential information about the company's financial health.
It aims to deliver transparency about a company's operations, financial position, and cash flows.

Financial reports include several key documents:
  • The balance sheet, showing the company's assets, liabilities, and equity at a specific point in time.
  • The income statement, which outlines the revenue, expenses, and profit over a specific period.
  • The cash flow statement, detailing the cash inflows and outflows from operating, investing, and financing activities.
Effective financial reporting enables investors and stakeholders to make informed decisions by providing insight into the company鈥檚 performance and potential issues, such as asset impairment.
Income Statement
The income statement is a financial report that details a company鈥檚 revenues and expenses over a certain period.
It is sometimes referred to as the profit and loss statement.

It serves several purposes:
  • Determining profitability by showing net income or loss.
  • Providing a breakdown of revenue sources and expense categories.
  • Offering insights into operational efficiency and management effectiveness.
In the context of asset impairment, impairment losses are recorded here.
They appear in a dedicated line under "income from continuing operations," thereby helping stakeholders understand their impact on the company鈥檚 profitability.
Impairment Loss
An impairment loss takes place when an asset's carrying amount exceeds its recoverable amount.
This situation indicates a permanent reduction in the value of the asset.

The impairment loss is calculated by subtracting the recoverable amount from the carrying amount.
This loss signifies that the asset cannot generate sufficient economic benefits to justify its current value on the balance sheet.

Steps to recognize an impairment loss:
  • Calculate the recoverable amount, the higher of fair value less costs to sell and value in use.
  • Compare it with the carrying amount.
  • If the carrying amount is higher, record an impairment loss in the financial statements.
If an impairment loss is recognized, it is crucial to report it in the income statement, impacting overall profitability.
Balance Sheet
The balance sheet represents a snapshot of a company's financial position at a specific moment.
It lists the company's assets, liabilities, and shareholders鈥� equity.

This document is vital for:
  • Evaluating liquidity by assessing current assets versus current liabilities.
  • Understanding financial leverage through the calculation of ratios such as debt-to-equity.
  • Tracking changes in asset values, including impairments.
When an impairment loss occurs, the asset's value on the balance sheet is reduced.
This reduction provides a more accurate view of what the assets are worth and may also lower equity if the impairments significantly affect retained earnings.
The balance sheet remains a fundamental tool for stakeholders, enabling them to gauge the risk and return profile of the company.

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Most popular questions from this chapter

In what way may the use of percentage depletion violate sound accounting theory?

Toro Co. has equipment with a carrying amount of \(\$ 700,000 .\) The expected future net cash flows from the equipment are \(\$ 705,000,\) and its fair value is \(\$ 590,000\). The equipment is expected to be used in operations in the future. What amount (if any) should Toro report as an impairment to its equipment?

A building that was purchased December \(31,1986,\) for \(\$ 2,500,000\) was originally estimated to have a life of 50 years with no salvage value at the end of that time. Depreciation has been recorded through 2010 . During 2011 an examination of the building by an engineering firm discloses that its estimated useful life is 15 years after 2010 . What should be the amount of depreciation for \(2011 ?\)

Mandive Corp., in accordance with iGAAP, applies revaluation accounting to plant assets with a carrying value of \(\$ 400,000,\) a useful life of 4 years, and no salvage value. At the end of year \(1,\) independent appraisers determine that the asset has a fair value of \(\$ 360,000\). Prepare the entries to record this revaluation and depreciation, assuming straight-line depreciation.

The plant manager of a manufacturing firm suggested in a conference of the company's executives that accountants should speed up depreciation on the machinery in the finishing department because improvements were rapidly making those machines obsolete, and a depreciation fund big enough to cover their replacement is needed. Discuss the accounting concept of depreciation and the effect on a business concern of the depreciation recorded for plant assets, paying particular attention to the issues raised by the plant manager
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